The flavour of the week, in terms of paths out of the recession, is asset sales. The story goes; “We are in recession. To get out of recession we need to spend money. To get money to spend we need to sell some assets.” Air tight logic if you ask some. There is, however, the elephant in the room. That elephant is how the government spends money.

Since the debt forgiveness episode in 2005 the federal government has increased its domestic debt from N1.5tn to N12.6tn as at January this year. It has increased its external debt from $3.5bn to $11.3bn. It has collected an estimated N84tn in oil and tax revenue between 2005 and 2015.

 

What has the FG done with this money? To say it has blown it is putting it lightly. The bulk of funds have gone to paying salaries, fuel subsidies, and in more recent years servicing already piled up debt. So much so that in the last two years they have effectively borrowed to pay salaries. The government apparatchiks will say that this regime has shown a dedication to focussing on capital expenditure and cutting waste. Well the reality is that recurrent expenditure is higher in absolute terms this year, than it was last year or the year before. The fuel subsidy is still technically there although with a different name. They have also introduced a new foreign exchange subsidy which is perhaps the worst of all.  Yes, ghost workers this and TSA that, but all that is akin to shaving the skin of the chicken when a leg needs to yanked off. The chicken being the civil service.

 

The question then is, if the federal government raises revenue from assets sales, will it blow it all again? And if it does, what happens next? Any asset sale discussion has to go hand in hand with a discussion on rebalancing government spending. Else it will just be another kick the can down the road exercise.

There are many other questions with regards to reforms, and transparency but we can save that for another day.

 

Note: In theory I am almost always for privatization, or sale of government assets, or whatever else it is called these days.

The monetary policy committee meets today to deliberate on actions to take particularly regarding the monetary policy rate. This is the first MPC meeting since the recession was confirmed, although most members already knew it was coming for a while.

The major question is if the MPC should cut the monetary policy rate? To be clear it not an easy choice either way. Ifeanyi Uddin has a good article on the arguments to raise or lower the MPR which hits the nail on the head.

I think it is difficult to argue for a rate hike given the deteriorating (or deteriorated depending on who you ask) conditions in the economy. Not asking for a rate hike is, however, not that same thing as asking for a rate cut. I don’t think a rate cut will be useful either. We all know the FGs borrowing plan this year and that is likely to be the key driver of interest rates for the rest of the economy. Lowering the MPR is likely to be toothless given that reality.

So what can the CBN do? The FX market still needs some fixing. The existence of the large spread between the official rates and the black market still sends all the wrong signals. The signal it sends is that everyone should still be in asset protection mode, and not investment mode. The CBN needs to change that signal.

My verdict for the outcome of the MPC meeting? I think they should hold.

First an experiment for you. Cut up a piece of paper into a dollar shaped rectangle. Write 1000 “your last name”s on it (For example, 1000 Obikilis if you were me). Sign it on both sides. Take it to your nearby corner shop and offer that in exchange for a loaf of bread. If that doesn’t work take it to the next one. If it still doesn’t work, try the next one. You probably already know where this will end. Odds are no one will accept your 1000 Obikilis for anything.

Now try a second experiment. Take a N1000 note, also a piece of paper cut in a rectangle with 1000 written on it but this time backed by the government of the Federal Republic of Nigeria. Try to exchange that note for a loaf of bread at your nearby corner shop. Odds are the seller will accept it in exchange for the bread.

What is the difference between your 1000 Obikilis and the N1000? Confidence.

What really happens when you exchange that N1000 for bread is that the trader, upon seeing that N1000, believes it to have some value. He or she believes that you could only have gotten that N1000 by exchanging something of value that you had for it. Either by working somewhere and collecting your share of the value created in notes. Or by building something valuable and exchanging it for notes. Or by selling something valuable you had. Or by stealing someone else’s value. The trader also believes that he or she will be able to exchange that N1000 note they got from you for something else of relatively similar value at a later date.

What matters to the trader is not what you call the note. It doesn’t matter if you call it 3000 naira, or 10,000 wizkids, or 200,000,000,000 jazingas. What really matters is if you exchange your loaf of bread for this note today, you would be able to exchange that note for a similar loaf of bread tomorrow, or something else of similar value. Money is really just the intermediary in your trade by barter and prices, the unit on the note, in absolute terms mean nothing but are all about comparing one set of valuable stuff to a different set of valuable stuff.

Once you start to think of money from this perspective you realize why the number one goal of the CBN is price stability. Or in terms of our model the confidence that if you gave up your loaf of bread for N1000 today, you would be able to buy a similar loaf for N1000 next week, or next month, or maybe next year. The confidence that if you save your notes in a savings account, the return you get at the end will be able to buy more value than before. The confidence that if you invest those notes in a good business today, the return on that investment will be able to buy more valuable stuff than if you spent those notes today.

Low interest rates are nice. Foreign exchange stability is cool. But none of those come close to the importance of price stability, aka keeping inflation reasonably low. And the confidence that comes with it.

Why am I telling you this story? Because it is clear that for a while the CBN lost its focus on price stability and tried to do other things. Things like forex exchange price fixing and industrial and trade policy. The result is that many have lost confidence in the Naira and in the ability of the CBN to implement credible policy.  What happens when people lose confidence in one note? They switch to another they have confidence in, like the US dollar.

Seems like the favorite past time nowadays is to bash economists. More recently the fate of the naira since the  alleged float has been to….you guessed it…bash economists for getting it wrong. I’m not here to indulge you. But I do think its important, even you are not an economist, to learn. Or at least try to learn more about how economies work. Or at least how we think economies work. So here are two things which are important in understanding Nigeria’s troubles today and the path to getting out of those troubles.

 

  1. Pains from unsustainable policy

    Can you remember that game we all played with rubber-bands when we were kids? The one where you get a rubber-band and latch on a folded of paper. And then try to shoot people with it by using the rubber-band as some type of missile launcher? It was a fun game. Sometimes it actually worked and you hit the target. Most times though you just ended up with pain on your fingers.

    Think about the mechanics of pulling the rubber-band. Once you start pulling you have to let go at some point. The longer you pull, the more stress you impose on the rubber-band. The longer you pull the more painful it will be on your fingers when you let go. But you know you have to let go at some point. If you don’t the rubber-band will break and the pain will be even more.

    Unsustainable policy kind of works in that way. You have a policy that you know can’t go on forever. The policy needs to end. The longer you hang on to the policy and the longer the policy distances itself from reality, the bigger the pain will be when you eventually let go. The pain is worst when the policy ends by force.

    We have seen many of such policies in Nigeria. The most notable is the fuel subsidy fiasco. A policy that went on for so long and at such huge cost to the country. And a policy that was forced to end due to the collapse of oil prices and government revenue. Cue the pain from sharp increases in fuel prices.

    More recently we have had the fixed naira policy. A policy that was unsustainable and a policy which sooner or later had to end. We held on for 18 months with the subsequent strain on the economy. It has ended and the pain is here with the sharp adjustment of the currency on official markets.

    The morale of the story? Don’t start unsustainable policy. Don’t even start. If you started by some kind of accident then let go as soon as possible. Because the longer you wait the bigger the pain will be when you do let go, by choice or by force. Also do not use the pain from letting go as an excuse to start unsustainable policy again. That only means future pain.

  2. The transmission mechanism.

    Say you have a plant that you are responsible for. Your orders are to water the plant once a day. And for the most part you do it diligently. But then you forgot about it. You didn’t water the plant on Monday. The plant isn’t going to die. It’ll probably be fine. But then you forget on Tuesday, Wednesday, and Thursday. By Friday the plant is on its death bed.

    The point of this story is that it takes time for your actions (or inaction’s) to become visible in the plant. If you implement a policy of not watering the plant on Monday, the plant won’t immediately die that same Monday. It will take a while before the plant dies.

    The same happens in reverse. You wake up on Friday screaming “Oh my God i forgot to water the plant”. You go ahead and water it. The plant is not going to miraculously regain its verve. It will take a while from when you start watering the plant again to when the plant regains its verve.

    Policy, especially monetary policy, works just like the watering plant example. We call it the transmission mechanism. If you implement a policy today, good or bad, it takes a while for the effects of that policy to show up in the economy.

    For example, if you implement a bad policy like trying to fix your exchange rates when you are faced with external shocks, it takes a while for that bad policy to cause a recession. You will not have a case where a policy is implemented on Monday and the effects on the economy show up on Tuesday. Economies don’t work that way. The exact amount of time is uncertain and probably depends on the country and specifics. For example, some studies argue that it takes about 18 months for interest rate changes in the United States to affect inflation.

    Similarly, if you implement a good policy, like abandoning your currency peg and floating the currency, it takes a while before the effects of the policy manifest on the economy. If you float the currency today, you are not going to see an improvement tomorrow. It will probably take months. And even that depends on the other policies you implement.

 

The morale of these two lessons is that we have had bad and unsustainable currency policy for the last 18 months, and bad fuel pricing policy for more than 18 years. And now we have let go. There will be pain during the adjustment. It is inevitable. And the pain will be proportional to the amount of time we hung on, so it will be a lot. We should not expect the positives of the abandonment of bad policy to show up immediately. It will take a while. But once the adjustments end then we should be on a more sustainable growth path. Conditional on other policies being reasonable of course. We shouldn’t attempt to go back though. That just means we are pulling the unsustainable rubber-band again, with the pain that comes when we inevitably have to let go, again.

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